Philly Fed Brings More Bad News  

A dismal manufacturing index reading highlights the risks to the U.S. economy that lie ahead.

TwitterTwitterTwitter
RobIsbitts310x310
|
Reviewed by: etf.com Staff
,
Edited by: Mark Nacinovich

While the stock and bond markets spent Thursday careening lower in reaction to the perception that the Federal Reserve will keep rates “higher for longer” rather than deliver the rate cuts many on Wall Street have been pleading for, one of the 12 Fed regional reserve banks slipped more distressing news by the goalie, while the market was focused elsewhere.  

It paints a picture whereby investment advisors must now watch several front-page risks become reality, while others start to bubble up behind them. The ETF industry has made defending portfolios against these risks a lot easier, once one has done the research.   

While the S&P 500's and Nasdaq’s recent pullbacks extended on Thursday, and the closely watched 10-year U.S. Treasury rate approached 4.5%, the Philadelphia Federal Reserve's monthly report on manufacturing sector posted an astonishing “miss.”  

Philly Fed’s Index “Just a Bit Outside”  

Economists expected the index to drop to 0.7 from 12.0 last month. The number released Thursday morning was, as baseball broadcaster Bob Uecker said in the movie comedy “Major League,” “just a bit outside.” This month’s reading was -13.5.   

Behind the current mix of market forecasters who say the economy is strong, weak, or in between, a set of traditional leading indicators are shouting “recession.” The Index of Leading Indicators has fallen each of the past 16 months. So, Philly Fed’s latest reading is not in isolation.   

Predicting the future isn’t part of the investment advisor’s job description. What is essential to how advisors handle investing part of being a fiduciary to clients (as opposed to non-investment financial planning) is managing risk. That risk can be dormant in the markets for a long time before it rears its ugly head.  

This week’s trading action in stocks and bonds, like that of 2022, reminds us that potential damage to portfolios can convert to hard dollars very quickly. Here are a few research considerations for advisors and investors.  

Some ETFs to Consider  

The ProShares Short Russell 2000 (RWM) may be as close to targeting a weaker small business environment as one can find in ETF form. It aims to deliver the opposite return of the most popular small cap stock benchmark on a daily basis.   

The Russell 2000 small-cap stock benchmark is 22% allocated to financial companies, including many regional banks that could still be a major risk, given higher interest rates.  

Slowing manufacturing activity hits smaller companies particularly hard. And, while the index has lagged the S&P 500 this year, it sells at a price-to-earnings multiple of 32 times trailing earnings, at a time when future earnings visibility gets cloudier by the day.  

Along the same lines, but via an ETF that acts differently than RWM, the ProShares Short High Yield ETF (SJB) tries to deliver the opposite return of a high-yield bond index.   

Concerns About Debt Refinancing  

Many high-yield bonds are issued by smaller companies, and there is growing concern about the amount of debt refinancing such companies will face in 2024, as their existing debt matures, forcing them to borrow at much higher rates than in past years. This increases interest costs; hits profit margins and likely leads to layoffs. But if that all comes to pass, SJB could be a port in the storm.  

Finally, a more aggressive inverse ETF option is the AXS Short Innovation Daily ETF (SARK) is structured to move opposite Cathie Wood’s popular and controversial fund, the Ark Innovation ETF (ARKK).  

ARKK has a five-year beta of 1.6, which means it is 60% more volatile than the broad stock market. And the ETF’s portfolio reports a negative P/E ratio, which leaves that mix of stocks vulnerable to continued news like what we saw out of the Philly Fed and the full Fed this week.    

Rob Isbitts' Wall Street career spans 5 decades and multiple roles, all dedicated to providing clarity to investors by busting classic myths and providing uncommon perspective. He did so as a fiduciary investment advisor, Chief Investment Officer and fund manager for 27 years before selling his practice in 2020. His efforts now focus exclusively on investment research, education and multimedia. He started ETFYourself and SungardenInvestment to provide straightforward commentary and access to his investment intellectual property for portfolio construction, stocks and ETFs. Originally from New Jersey, Rob and his wife Dana have 3 adult children and have lived in Weston, Florida for more than 25 years.